Another Advantage of Individual Retirement Accounts

Rolling-dollarsOne potential benefit of IRAs is creditor protection in the case of a bankruptcy. However, you would be correct to question whether or not that protection extends to your beneficiaries.

Investors need to know how their assets can be better protected in the event of bankruptcy or lawsuits. We’ll look at some of the issues facing IRA investors and their beneficiaries when it comes to bankruptcy and items to think about when naming an IRA beneficiary.

Bankruptcy. Similar to the protection offered to pensions, 401(k)s and Social Security benefits, IRAs can be protected from creditors in bankruptcy. If you declare bankruptcy, your IRA assets will typically be safeguarded and can’t be taken. However, this doesn’t extend to other types of judgments, civil lawsuits, or IRS levies. State laws will vary, but your IRA assets may be protected from other creditors. There is a $1 million inflation-adjusted limit that applies to federal bankruptcy protection rules for the aggregate value of Contributory and Roth IRAs (with inflation, the limit is $1,283,025 as of April 1, 2016). Assets rolled over to an IRA from a qualified plan, like a 401(k), aren’t subject to the same dollar limits and can be fully protected.

Beneficiary Protection? Not anymore!   While it is trust that IRAs offer the simplicity of selecting a beneficiary to receive the money when you die thereby avoiding probate, a recent Supreme Court decision stripped these inherited assets of their asset protection. When the owner dies, and the non-spouse beneficiary takes ownership of the account, the assets are no longer deemed retirement funds, and can be seized in bankruptcy. This only applies to non-spouse beneficiaries because a spouse can roll over inherited IRA assets into his or her own account. However, a non-spouse beneficiary can’t comingle inherited IRA assets with their own retirement assets. Therefore, it is best to provide these assets to your heirs in a trust specifically designed to take advantage not only of the asset protection the trust can provide but the stretch provisions that make these such a wise retirement tool as well.

Your trust as beneficiary. Here is how a trust can provide asset protection to your IRA:  include conduit trust provision in your revocable trust or create an IRA trust and list that trust as beneficiary of the IRA and not the individual heirs. As a result, an inherited IRA payable to a trust can be protected from the beneficiary’s creditors while still allowing the loved one to benefit from the inheritance. The IRA’s required minimum distributions are calculated on each beneficiary’s life expectancy (within their trust share), and income is taxed at the beneficiary’s tax rate. Since the assets aren’t legally owned by the beneficiary, they’re protected from creditors in most instances. However, keep in mind that once the income is paid out to the beneficiary, that income isn’t protected.

It is important to review your beneficiary designations regularly because your goals and circumstances may change over the years. If a beneficiary is experiencing financial difficulties, you may want to try to protect them and to protect your legacy. In addition, the laws can change over time, and there may be particular nuances to creditor protection in your state. You should speak with a qualified estate planning attorney before you make any changes.

Reference: Forbes (December 9, 2016) “Estate Planning Tip: Creditor Protection for IRAs & Beneficiaries”


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